“The Only Free Cheese is in a Mouse Trap.”
By John E. McNellis, Principal at McNellis Partners, for The Registry:
I had the following conversation with a broker a couple days ago. While not verbatim, it is true.The phone rings.
“Hey, John, it’s Joe Smith. How you doing,” the broker asks.
“Fine, what can I help you with?”
“I’ve got a really interesting deal for you,” Joe says enthusiastically. “It just went on the market.”
“Hit me with it.”
“It’s the Parkwood Center in Townville. We think it has a lot of upside. It’s got a couple developable pads and—”
That worn-out word upside catches my attention as I’m reading an unrelated email. Trying to focus, I ask, “Why do we want to buy it?”
“It’s got real upside, you can reposition the supermarket, move a couple of the junior anchors around, bring in a new major, get the shops to market rent and you’ve got—”
“–Why is the seller selling,” I interrupt.
“He’s having trouble with his financial partner. We really like this deal—”
“–Who’s the seller,” I interrupt again. Bad habit but useful.
“Gem Tree Partners. Their money guy doesn’t want to finance the redevelopment.”
“Gem Tree Partners? That’s John Reid’s company, right?”
“Yes, his partner—”
“–Wait. The Parkwood Center in Townville,” I ask. Shallow-rooted memories emerging.
“Yeah, that’s it.” Optimism in his voice.
“I know that project. It’s at the corner of Caveat and Emptor?”
“It’s an oversized Pay-More market of about 65,000 feet that should be no more than 40,000, right?”
“Yeah, you got it.” Optimism ticking down a beat.
“And it has a 20,000 foot closed drug store and a 30,000 foot R&M tucked into a corner with almost no visibility? And R&M is threatening to vacate unless the owner builds it a new 15,000 foot store on the hard corner at a ridiculously low rent?”
“Well, yeah, I guess.” Optimism gone.
“It’s on about 25 acres, the center is too big by at least 150,000 feet and it has zero tenant interest?”
“You know this center pretty well, huh?”
“And it’s cut off by better supermarkets a ½ mile in either direction on Caveat. And because the town has no growth, there’s no residential or any other redevelopment play. That Parkwood Center?”
“Yeah, that’s it. How do you know so much about it?”
“Reid is a friend. We met over this deal and I told him to hand the keys to his lender.”
“Oh.” Total gloom.
“This is the worst deal you’ve ever pitched me. My advice to you: Don’t sell it to anyone you know or anyone you ever want to talk to again.”
I ended the conversation deciding not to take his future calls, wondering whether he would take my comments to heart, whether it would dissuade him from pitching this career-busting deal to others. I thought not.
Joe had either learned almost nothing in his twenty years in the business or was knowingly willing to strap a buyer into a rocket with a broken fuel-line. Was his pitch negligence or fraud? On reflection, I decided it had to be the former, the careless offspring of his cupidity and lack of intellectual curiosity (that is, unencumbered by the knowledge of what a successful redevelopment requires, he can pitch anything). Had Joe truly understood the center’s dismal prospects, he would have called someone else. I also decided his intent didn’t matter. Whether Joe is guilty of murder one or involuntary manslaughter, the result is the same, the buyer will ultimately die.
What does this conversation tell you?
If you’re a broker, it should be telling you to choose your listings carefully because the only question on projects like Parkwood will be how much of your reputation you will lose by pitching it. And that depends on whether you actually manage to sell it. If economic necessity requires you to take a Parkwood listing, at least do your best to figure out its potential downside and disclose that upfront. If Joe had first outlined Parkwood’s flaws and then said, “But remember there’s no such thing as bad real estate, only bad pricing. Maybe it will work for you at some number,” he would at least have maintained some credibility.
The lesson for principals is obvious: The only free cheese is in a mouse trap. Learning to recognize the trap of easy upside without breaking any fingers is part of the tuition one must pay to become proficient in real estate. Start by always doing your own underwriting. And if you’re not experienced in underwriting a particular property type, find someone trustworthy who is or skip the deal. By John E. McNellis, McNellis Partners, author of Making It in Real Estate: Starting Out as a Developer. The article was first published on The Registry.
That retail is overbuilt is obvious to anyone who has driven 20 miles in America. Less obvious is the why of over-building. Read… Over-Storing America